We have argued that the recycling of private sector surplus from the northern countries in the euro area to the southern debtors is the key mechanism that has broken down and is causing a disruption in the transmission of the ECB's monetary policy. The upward pressure on the Swiss franc emanates from the same source.
The private sector is not recycling Switzerland's current account and financial account surpluses. Reports suggest that the private sector in Switzerland is content to leave their savings at home. We have noted the distortions this causes. The SNB's currency cap is, in effect, doing what the private sector refuses to do.
S&P has a report out today called "How the SNB is Driving Down Yields for Eurozone Core". It estimates that SNB has bought 80 bln euros of core European bonds (Germany, France, Netherlands, Finland and Austria). This is equivalent to almost half of the estimated total deficit of these core countries. S&P estimates that last year, the SNB purchases of core bonds were a little less than 10% of the combined core deficits.
The SNB's recycling has seen its reserves rise to almost 80% of the country's GDP (~$635 bln or about 1/3 the size of Canada). S&P estimates prior to the crisis (July 2008) were about 15% of GDP.
Japan, of course, faces a similar problem, but it is much larger and its trading partners are more sensitive. Japanese investors do not appear to be buying a sufficient amount of foreign assets to offset its current account surplus and foreign investors' purchases of Japanese bonds (foreign holdings are at a record) and Japanese equities.
Despite trying with huge size ($100 bln in a single day), BOJ intervention has not been particularly successful in capping the yen's gains. The Swiss intervention has not received nearly the level of criticism that Japan's unilateral intervention efforts have. The lack of U.S. (and European) support does not seem to prevent MOF ordering intervention, but perhaps encourages it to be more selective in picking its shots. Despite the dollar spending some time below JPY78, we would locate Japanese officials presently hardly even on the intervention ladder. Look for verbal intervention to increase as the JPY77 area draws near.
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